The U.S. Economy Stinks, but the Dollar Smells Like a Rose

An advance report of third-quarter U.S. GDP showed a decline of 0.3%. That’s awfully pathetic, right? But not quite as pathetic as the 0.5% that was anticipated …

Still, there’s no denying that a GDP contraction of any amount is unappealing. And when it comes to many of the recent U.S. economic indicators, most everything’s been unappealing … if not downright ugly.

But across the pond we’re finding that Europe’s economy is uglier yet.

The U.S. Economy Stinks,
But Currency Traders Don’t Smell a Thing …

Investors who haven’t let up on the doomsday scenario and still believe that the buck is going to hell in a hand basket are getting their heads handed to them.

Because even though the U.S. economy stinks right now, the U.S. dollar smells like roses. And the dollar index has surged as much as 16% in just the last three and a half months.

The analysis of global money flow has changed. Currency traders are doing just what they should: They’re looking past purely domestic fundamentals and going global with their assessments.

The financial crisis impacting the globe is front and center. And when you think about the U.S. position amongst the ruckus, you realize the U.S. and the dollar aren’t quite as bad off as many domestic seers, or those with a vested interest in the dollar doomsday story, would have you believe.

One of the key items U.S. dollar perma-bears mold their argument around is the U.S. current account deficit. But I’m of the opinion that the current account is of little, if any, relevance as it pertains to the multi-trillion dollar economy and, more specifically, the U.S. dollar.

The New Concern:
Toxic Economies …Lacking many features of strong, well-rounded economies, emerging markets have put all their chips into their exports sector. They’ve come to rely almost entirely on neighboring and developed economies buying up cheap goods and raw materials. And they failed to adequately invest in the domestic side of their economies, leaving them woefully exposed to external demand for growth and foreign investors for funding.

That generous global demand has plunged. Therefore, it’s easy to understand why emerging economies’ stocks and their currencies are being hit the hardest.

What’s more, as quickly as these economies gained the backing of foreign investors in the last couple years, these same foreign investors are running for cover just as fast.

When it comes to emerging markets, Eastern and Central Europe account for $1.6 trillion in loans from G10 countries’ banks. Asia and Latin America are next on the list — recipients of $1.5 trillion and $1 trillion, respectively, according to Morgan Stanley’s Global Economic Forum.

And if you break down the loan originators, Western Europe and the United Kingdom are where roughly 45% of these emerging market loans came from. Whereas only 9% originated from U.S. or Japanese banks. In fact, European and UK banks are more exposed to emerging economies in Eastern Europe, Asia and Latin America.

Take, for example, the situation in Hungary.

It’s believed that nearly 90% of mortgages in Hungary are denominated in Swiss francs, not Hungarian forints. In other words, banks in Switzerland are extraordinarily exposed to Hungary’s emerging economy. That means the Swiss are exposed to a rising number of defaults.

And this is not an isolated incident. Western Europe and the UK have been extremely active in cross-border lending. And it’s going to come back to bite them.

So …

The Flight to Safety Gives
The Dollar the Upper Hand …

The global stock markets’ decline and the rush to safety is creating demand for dollars.

I’ve taken a long-term dollar bullish view. But even I have been surprised by the greenback’s persistent strength.

The dollar’s historic move is showing that it has the upper-hand in what’s become a nasty currency beat-down. And the deleveraging that’s taking place in emerging markets is fueling the drive. Also helping out is significant repatriation of funds to the U.S., a risk-averse environment.

The downturn overseas and rush to the exit, evidenced in global stock markets’ decline, is simply creating demand for dollars.

Specifically, I’m looking for this skirting money flow and overexposure to emerging market debt to further weigh down the euro and the British pound for the next several months.

We’re seeing proof that the dollar is nowhere near forfeiting its position as global reserve currency. After all, the credit and economic crisis isn’t sending money to Europe for safety.

So whoever thought the euro was ready to fulfill the role of world reserve currency can think again.

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.

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